It is frequently desirable for parties to exchange cash flow streams having different term structures or risk profiles but similar net present values. Three examples of such exchanges are known in the financial industry as interest rate swaps, currency swaps and commodity swaps.
In one common interest rate swap transaction, a first party agrees to pay to a second party a fixed rate of interest for a certain period on a given sum in exchange for receiving from the second party a floating rate of interest on the same sum (the “notional amount”) for the same period. Market practice is for one party to pay the other the net of the two interest payments on each payment date. Such a transaction is known as a “fixed-for-floating” swap. In most cases, the notional amount need not be exchanged.
In a common currency swap transaction, a first party exchanges a given sum in a first currency for the same sum in a second currency from a second party. For a certain period, the second party pays a first rate of interest on the given sum in the first currency to the first party, and the first party pays a second rate of interest on the given sum in the second currency to the second party. At the end of the period, the sum is re-exchanged at the original exchange rate. In practice, only the difference in the amounts adjusted for exchange rates need be exchanged.
In a common commodity swap transaction, a first party agrees to pay to a second party a fixed price per unit for a given number of units of a commodity (such as oil, electricity, corn or telecommunications capacity) per period over a certain number of periods in exchange for receiving from the second party a market price (determined by previously established means) per unit for the same number of units per period and periods. Again, market practice is for the parties to exchange the net of the two payments on each payment date, and the commodity itself need not be exchanged.
More generally, such transactions typically may be characterized by one or more underlyings (two in the swap examples above), a notional amount, and a payment provision. An underlying is a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, or other variable. A notional amount is a number of currency units, shares, bushels, pounds, or other units specified in the contract of exchange. Settlement is determined by interaction of the notional amount with the underlying, which may be multiplication, or a more complex formula. A payment provision specifies a fixed or determinable settlement to be made if the underlying behaves in a specified manner. These and related terms as used herein are intended to be consistent with Accounting for Derivative Instruments and Hedging Activities, Statement of Financial Accounting Standards No. 133 (Financial Accounting Standards Board, 1998) (“FASB 133”).
By means of such exchanges of cash flows, parties may apportion and exchange risks, such as the risk of interest rate change, currency valuation change or commodity market price change.
Certain types of such exchanges, such as relatively short-term exchanges and/or those for which one party pays a lump sum, may be relatively easier to market than more complex exchanges. Some, including futures and options, are sufficiently standardized to be traded on market exchanges. Others, such as those for which both parties have structured payment terms and/or those with relatively longer terms (including swaps such as interest rate, currency and commodity swaps), are typically custom-brokered arrangements.
For example, in the past parties seeking counterparties for a swap transaction have found it necessary to use swap facilitators, in part due to very significant search costs associated with finding potential counterparties who have matching needs. See, e.g. Kapner, et al., The Swaps Handbook, p. 27, et seq. Investment banks, commercial banks, merchant banks, and independent broker/dealers traditionally have fulfilled the role of swap facilitators as swap brokers or dealers, taking for their efforts a commission or pricing differential between amounts bid and asked for particular transactions. It has been difficult or impossible for a party seeking a swap to locate a suitable counterparty without incurring the costs of such facilitators.
In many instances, facilitators of swap and other relatively complex exchanges have acted as a counterparty in transactions when they have been unable to locate exactly matching counterparties for a desired transaction. In such instances, it has been difficult for facilitators to ensure that their own positions with respect to one or more such exchanges (typically a portfolio) are hedged in a fully effective manner.
The present invention is directed to overcoming these and other limitations of existing methods and systems for facilitating exchange of structured cash flows by permitting counterparty-seeking parties to locate and deal directly with each other, while preserving many of the benefits formerly achieved only through intermediation by a third-party swap facilitator, and creating new benefits for market participants. The present invention is also directed to assisting third-party facilitators to more effectively intermediate exchanges of structured cash flows and act as counterparties in transactions while ensuring that the facilitators' positions with respect to such exchanges are fully and/or effectively hedged.